“We’re Not Dangerous”: Deutsche Bank’s Chief Risk Officer

No crisis at Deutsche Bank, really, I swear.

When Stuart Lewis, Chief Risk Officer at Deutsche bank, was asked in an interview, published in the Frankfurter Allgemeine on Sunday, if his institution is “the most dangerous bank in the world” – a reference to the IMF’s call that among globally systemically important banks, “Deutsche Bank appears to be the most important net contributor to systemic risks” – he replied:

“No, not at all. Only one IMF report has recently muddled up the situation: We are not dangerous. We are very relevant. Deutsche Bank is interwoven with the entire financial sector. We are one of the largest universal banks in the world. But to make it clear: Our house is stable. The balance sheet is healthy.”

Could he say that “in good conscience?”

“Absolutely. Look at how we have capitalized the bank since the Financial Crisis. We have taken €115 billion in risks off the balance sheet and have €220 billion of liquidity. Concern for us is unfounded.”

Alas, the European Banking Authority released the stress test results on Friday. Deutsche Bank didn’t fail in part because there was no way to fail. No bank could fail, not even Italy’s Banca Monte dei Paschi di Siena which is in full collapse-and-bailout mode at this moment. Mercifully, no bank could fail the test by design. But the Tier 1 capital ratio after in the “adverse scenario” made it possible to rank the banks. At Deutsche Bank, that ratio dropped to 7.8%, making it the 10th riskiest bank among all European banks in the stress test.

Commerzbank, the second largest German bank, which was already bailed out by the government during the Financial Crisis, and which is still partially owned by the government due to this bailout, was the 8th riskiest bank, ahead of Societe Generale in 9th place and behind Barclays in 7th place. Then came Irish, Italian, and Spanish banks. In third place was the Austrian cooperative banking group Raiffeisen-Landesbanken. In second place, Allied Irish Banks. And of course, the winner, Monte dei Paschi.

In June, a US unit of Deutsche Bank, Deutsche Bank Trust Corp, had failed the Fed’s stress test for the second time. The Fed lamented its “material unresolved supervisory issues that critically undermine its capital planning process.”

So Deutsche Bank, unlike Monte dei Paschi, isn’t collapsing at the moment. But investors are not entirely convinced. Its shares closed at €12.00 on Friday and are barely up from their multi-decade low of €11.38 on July 7. But there’s no reason to worry about a taxpayer bailout.

Lewis explained:

“The good news is: the taxpayer does not have to step in; according to the new regulations for banks, bondholders will get hit first.”

That would be good news for taxpayers. But even as Lewis said it, Italian and European politicians and bureaucrats were creating exceptions for the Italian banks in order to spare regular Italians huge losses. They’d been hoodwinked into buying junior bank bonds because they offered higher yields than savings accounts. These folks own about €300 billion of these misbegotten bonds, which, under the new banking regulations cited by Lewis, should get bailed in. But no way. It might trigger an Italian revolt against the euro and the EU.

So somebody else is going to bail out these banks. Lewis’ colleague, Deutsche Bank chief economist David Folkerts-Landau, already called for a €150 billion bailout of European banks, funded by taxpayers. So Lewis might want to check with him at their next lunch.

And besides, Lewis said, the stress test result, which landed the bank in the 10th worse position, was “a good result.” Better than in 2014, “even though the test was much harder.”

So there’s nothing to worry about. “The quality of our balance sheet is great, and we did really well even with the risk of default on loans,” he said. The reason why Deutsche Bank did so badly compared to other European banks was “mainly due to the operational risks….”

Ah yes, the never-ending stream of legal problems. After years of settling cases and paying fines and penalties, the bank still faces 7,000 lawsuits and regulatory actions, including on the front burner, a US investigation into its mis-selling of mortgage-backed securities, and a joint US-UK investigation into $10 billion of suspicious trades involving Deutsche Bank’s Russian entity. New cases pop up faster than it can settle the old ones. Lewis explained:

“These are the non-balance sheet risks that could result in particular from the conduct of employees or inadequate controls. The testers extrapolate from the past into the future. And it happens to be a fact that the legal cases since 2012 have cost us more than €12 billion. We’re still suffering from that. We have currently reserved another €5.5 billion for it. That’s the reason why others do better in the stress test.”

Wisely, Deutsche Bank’s elephantine exposure to derivatives didn’t even come up. It’s better to silence the topic to death than to cause a panic with it.

In this negative interest rate environment, it’s difficult for banks to make money. “All banks are struggling with that,” he said. “It’s hard to survive for long with low interest rates. But Deutsche Bank traditionally gets a higher proportion of its income from fees, so we have an advantage,” he said, even as the collapse of investment banking fees is precisely what had hammered Deutsche Bank’s earnings over the past few quarters.

He refused to forecast how long the low interest-rate phase would continue but said, “All I know is that low interest rates hurt the banks, without stimulating the economy.”

“But even as Lewis said it, Italian and European politicians and bureaucrats were creating exceptions for the Italian banks in order to spare regular Italians huge losses. ”

We are quickly reaching the point where more visible entities than abstract ‘taxpayers’ are going to get hurt badly. Of course taxpayers aren’t really hurting yet from past mischief, because most of the debt has been postponed to eternity (they hope) thanks to ZIRP/NIRP.

My bet is that the small Italian bondholders are up for significant losses; the same happened before e.g. in Spain (with smaller banks) and if they make an exemption now they would have to do the same even more for all savings account depositors in future. And without that money the bailouts are simply impossible, because there isn’t that much to skim from bigger bondholders if you exclude FED/ECB and take potential lawsuits for those above the law into account.

The wheels are coming off, will be interesting to see how they keep spinning this …

MC

Aug 1, 2016 at 3:26 am

Yesterday evening I was reading the details on MPS proposed bailout: proposed because all final decisions have in fact been deferred to September.
Leaving everything else aside, bondholders will take a hit as their securities will be converted into equity at a discount. To make matters worse even if everything goes according to plans, shareholders face a 70-80% loss through diluition alone.
Yes, then there are the small details of government guarantees for the securitation vehicle, the “emergency bailout” fund Atlante being wiped out in a single stroke and the fact nobody knows who will step in to provide the €5 billion capital increase, but let’s not worry about those details.

Let’s focus on retail bondholders and shareholders. Like it happened with Banca Etruria, these are mostly concentrated in the so called “Red Fortresses”, areas where the old Communist Party and now the ruling PD have always been sure to get 70-80% of the vote no matter what.
The deeply euroskeptic M5S has been chipping away at these Red Fortresses like a medieval siege engine, slowly gaining traction and scoring electoral victories in old Communist strongholds such as Livorno, Parma and Comacchio.

The last thing the ruling PD needs right now is more of their voters seeing their savings wiped out for trusting banks that would be bailed out no matter what thanks to their political connections.
There have been frantic attempts to make Banca Etruria bondholders (and those of three other local banks which defaulted at the same time) whole one way or the other and, due to a minister’s family being deeply involved in the burst, sweep the scandal under the rug. Nothing is working so far. Plainly put there are neither funds nor legal ways to make bondholders whole and the Banca Etruria management acted so inconsiderately their deeds make good headlines.

Now allow me to say one thing. Most Europeans have no idea how big and serious this banking crisis is. Many still live under the distinct impression banks will be “bailed out” one way or the other and that bail-in’s are just a passing fad. They confuse bondholder bailout’s with deposit guarantees and think they are one and the same: they don’t realize guarantees only cover cash, not securities and equities.
I have relatives who have taken a true beating by listening to bank managers and buying bank equities. They would have done better to buy sovereign bonds, even at a negative yield.
I am beginning to suspect this thing is far bigger than 2008…

John S

Aug 1, 2016 at 12:12 pm

I suspect that many, if not majority of loans taken out in Europe (especially southern portion) currently are done so with no intention of ever being paid back. The corporate officers set up grossly overpriced supplier contracts and in exchange get kickbacks through various means. Company having overpaid is saddled with debt but without productive assets. Corporate officers walk away rich while the corporation flails around with government help until closing down.

ECB is trying to force banks to make more loans to jump start the economy but in reality they are just increasing the amount of non-performing loans that these banks will have within a short time.

I sometimes wonder if there will be a banking system in Europe and what it will look like.

Mo

Aug 3, 2016 at 4:43 am

He talks like he’s in control of DBs risks but he’s not. It’s just bull from a man who has specialised in fronting and fakery. DBs financial risk management is the biggest mess I’ve ever seen.

micromacroman

Aug 1, 2016 at 8:20 pm

I am old enough to remember the congressional debates during the passage of “Graham-Leach-Blilly” which repealed the glass-Steagal act. That was back in 1999. American banks have atiquated banking laws from the 1930’s and we can not compete with European banks in the “New Global Economy”. I remembered all through college in the early 80’s were were taught that Glass-Steagall was what led to 50-years of banking and economic stability….hmmm

Al Tinfoil

Aug 1, 2016 at 4:04 am

Well, I am glad to hear that all is well in EU bankland. That nice Mr. Draghi and nice Wolfgang Schnowball have acted to reassure the public that “No Bank Will Be Left Behind”, or something like that, while some manoeuvre has been found by the Italian government to paper over the mess of Non-Performing Loans in their 3rd-biggest bank, so Extend and Pretend can put on another run at the local theaters.

It is soooo reassuring to know that it is safe to put my money in the bank, that the local ATM will always spew out cash when I put in the correct codes, and that the local merchants will continue to accept a swipe of my credit card in return for merchandise.

I would love to continue this conversation, but I have to go check my mailbox to see if my government cheque has arrived. Ciao!

While I am somewhat to the right of “Attila the Hun” politically, It should be a rule that what the taxpayers pay for, the taxpayers own, from the results of pure scientific research to the “rescued” banks, brokerage houses, contract futures merchants, and insurance companies.

Most likely it will not be practicable for the government to operate the financial institutions long-term, but bankruptcy (to void existing employment contracts, deferred compensation schemes, bond debt, leases, etc. ala GMC) and reorganization/reconstitution under under government control, with the removal of the officers, directors, and cadre management that caused a “rescue” to be needed, before the organization is “privatized,” via a normal IPO, with the profits going to the U. S. Treasury rather than PE seems entirely feasible.

Chip Javert

Aug 1, 2016 at 5:06 pm

George

I feel & share you pain.

US banks can’t file bankruptcy, they are “resolved” (bank holding companies may file bankruptcy only for non-banking legal entities). This is because assets of failed banks are, for the most part, consumer deposits (technically deposit accounts are bank liability, and resulting cash is an asset, but we’re quibbling).

Excluding “too big to fail” banks (Petunia has some nice comments about them), resolution generally works as follows:

I ABSOLUTELY AGREE THIS SHOULD HAVE HAPPENED TO CITI CORP AND BANKOFAMERICA IN 2008. Each bank would have had about 50,000 non-branch managers and investment bankers thrown out on the unemployment line. Instead, a huge component of this cadre of 100,000 failed bank managers are still at CITI & BofA or elsewhere in the industry.

Petunia

Aug 1, 2016 at 8:58 am

For those of you who have not been paying attention to the banking sector since the 1980’s, I will personally guarantee you that none of the big banks will be allowed to fail, if you hadn’t already noticed it to be the case.

$ity bank was insolvent for most of the 80’s and everybody knew it and it didn’t matter. That should have been a really good clue to the clueless. Then there was LTCM, the hedge fund bailed out to protect the banks, another clue. We are all aware of recent history so I won’t continue, but it is also a clue.

That putrid mess in Italy will also be rescued, they will then say they have been in banking for hundreds of years, and investors will flock to it once again. Rant officially over. Now to a really interesting banking story.

A bank in Florida, Colonial, is suing PriceWaterhouseCooper over its default. This might finally shed some light on the worthlessness of auditing firms and their culpability in the financial disaster we call the economy.

That’s the problem with stress tests. Crises that precipitate bank failures are black swans, in the Nassim Taleb sense. You can’t predict them.

You can’t predict their arrival. You can’t predict their structure. You can’t predict the all the ways that financial institutions will break.

The false confidence around “manageable” risks is infuriating. Our global financial system is broken, at least at the levels of the largest institutions. The industry and its regulators are wasting a lot of time on a lot of issues that matter very little.

Petunia

Aug 1, 2016 at 9:37 am

Not to mention that the risk models change as needed. I’ve never seen one published so we could all following along, to see if the math works.

RE: … I’ve never seen one [risk model] published so we could all following along, to see if the math works.

—–

The assumptions and initial state data (GIGO) are the killers.

How big are these models? What language are these written in? (C?, Java?, Excel/VBA?) How are these audited/verified? Can we get a few (with the initial state database(s) up on Get-Hub?

With the huge increase in computational power now available, it would appear reasonable to conduct “sensitivity analysis” using Monte Carlo simulation to develop a probabilistic prediction model of banks’ performance. This should be possible on a high-end lap or desk top computer.

Chip Javert

Aug 1, 2016 at 5:34 pm

Regulators currently allow each bank to have their own risk models. Banks (especially too-big-to-fail-banks) literally hire PhD math & physics guys to develop & maintain this stuff. To some extent, these have to be different for each bank because each bank’s business assumptions & book of business is different.

These are classified as corporate competitive secrets and are not disclosed by regulators or any other process that I’m aware of.

Most large ones are probably a couple hundred pages long, and unless you are very good at partial differential equations (PDE) and other higher level math, you couldn’t begin to understand them.

Einstein’s special relativity is just 23 pages long and about 0.01% of the world’s population can understand it (actually titled “On the Electrodynamics of Moving Bodies”).

A few observations:
—–
Regulators currently allow each bank to have their own risk models.
{How smart is it to allow the banks to optimize/minimize their own risk analysis?}
—–
Banks (especially too-big-to-fail-banks) literally hire PhD math & physics guys to develop & maintain this stuff.
{If it is this complicated, most likely the intent is to obscure rather than illuminate, e.g. Enron SPIVs}
—-
To some extent, these have to be different for each bank because each bank’s business assumptions & book of business is different.
{Why should the banks get to select their business assumptions? This is exactly what the GAAP [Generally Accepted Accounting Principles] are intended to prevent and they all operate in the same socioeconomy. The inflation rate, prime interest rate, etc. will be the same. One risk analysis program with individual data bases with identified asset classes, maturities, etc. seems to make more sense and would allow apples v apples comparisons between banks.}
—–
These are classified as corporate competitive secrets and are not disclosed by regulators or any other process that I’m aware of.
{At the very least the assumptions (with justifications/rationales) should be public. For example if one of the basic assumptions is 20% ROI under worst case conditions, the “value” of the risk analysis is apparent.}
—–
Most large ones are probably a couple hundred pages long, and unless you are very good at partial differential equations (PDE) and other higher level math, you couldn’t begin to understand them.
{If the analysis does contain PDEs and/or convolutions, its another reason for calling Bull S**t! This violates the K.I.S.S. Principle, and ignores the proven process of eating the elephant one byte at a time to solve complex problems.}
—–
Einstein’s special relativity is just 23 pages long and about 0.01% of the world’s population can understand it (actually titled “On the Electrodynamics of Moving Bodies”).
{The Special and General Theories of Relativity are now taught in Freshman physics at University}
—–

The computational problem is the valuation of the assets and liabilities under different conditions. While point estimates can be calculated, it makes more sense to do a probabilistic/Monte Carlo analysis with a statistical distribution for the asset and liability class values based on historical data, which would also allow sensitivity analysis for valuation ranges of the assets/liabilities and conditions such as discount/inflation rates. This avoids the illusion of certainty by generating a probability distribution of insolvency for various [stated] assumptions, e. g. all other things being equal, if the discount rate goes to 5%, and 25% of the credit default swaps require payout, there is 14% likelihood that equity will be zero or less.

FWIW – generally the probability density functions for the asset/liability classes and economic conditions should not be Gaussian, but rather l-stable or Levi to accurately model the “fat tails” of real financial data.

Chip Javert

Aug 1, 2016 at 8:28 pm

George

I think you misunderstood me – I’m definitely not justifying what the banks do – I was explaining what currently actually happens (as retired Fortune 500 CFO I’ve been there & done that).

One minor quibble: special & general relativity can certainly be taught to almost any post-secondary student (Princeton teaches a class expressly for liberal art students).

Knowing about the theories is definitely not the same as understanding the theory’s equations, which requires advanced math (special relativity – lots; general relativity – a whole lot). You show me a college freshman conversant in partial differential equations and Einstein tensor analysis and I’ll show you a kid who will make a fortune writing risk models for a large bank.

Chip Javert

Aug 1, 2016 at 9:16 pm

George

One other quibble – GAAP (an accounting treatment) has almost nothing to do with a risk model.

Example of risk model:

Bank A makes only car loans and has modeled the bad debt as function of unemployment rate (sophisticated model would use PDEs);

Bank B makes car, home and boat loans, and also modeled car loans to unemployment rate. Heuristically it observed customers having car + home loans have losses 25% less that Bank A’s. Car + boat loans are 33% less; car+ home + boat is 45% less (model undoubtedly has lots of PDEs).

Bank A and Bank B’s risk models both contain business assumptions having absolutely nothing to do with GAAP (other than booking the calculated bad debt reserve). GAAP says nothing about forecasting unemployment; correlations between loan losses and unemployment, multi-product pairs that reduce losses.

Bank B definitely does not want Bank A to find out multi-product customers experience reduced loan losses. Bank B considers this knowledge a competitive secret and so do the regulators.

PS fair size banks easily have thousands of products, depending upon its analysis of how they interact and financially perform. This quickly becomes a non-trivial problem for your high-end desk top computer.

Still unclear why PDEs required. If the relationships are derived from empirical data using most multiple regression programs you will get a LSBF equation so the residuals can be calculated. Once you have the equation, calculations for Monte Carlo simulation need not directly use the equation as it can be faster to use linear approximations and case statements. The R^2 Coefficient of Correlation and confidence intervals are also critical information to determine the reliability of the model’s inputs/assumptions, and should be included in the model documentation.

In this era of big data analysis and managerial accounting, any belief that there is some magical “secret sauce” that will give you a competitive edge is a pipe dream. Safe debt loads for individuals and companies have long been know, and no amount of sharp pencil “financial engineering” or euphemisms (e. g. sub-prime loans) will change the outcomes.

As for the thousands of products, there are only a few basic types, which should be in data bases, categorized by face/net value, type of transaction, maturity, etc. linked to principal demographics in another database, perhaps by social or account number. It is then trivial to “cross tab”/subtotal the information using SQL type freeware for analysis by multiple regression or canonical analysis using freeware such as “R” to establish strengths of relationships. While this can be tedious, it is NOT “rocket science,” and does not require number theory. IMNSHO anything more is just updated Astrology/Numerology to impress the rubes, and generate consulting fees. In general the problem seems to be that “management” does not like the results, and keeps spending more and more money to get an analysis/model showing what they want to see (or to show to the regulators).
—–
RE: Bank A and Bank B’s risk models both contain business assumptions having absolutely nothing to do with GAAP (other than booking the calculated bad debt reserve).
{ Indeed these do, but it can be important to determine when profits/losses are to be booked, how liabilities are recognized and how/when SPIVs are to be recognized, so the models (and the banks) can be compared apples to apples. These need not be strictly GAAP compliant as long as these are consistent across models/analysis (and have some connection to reality).}

“Black swan” is a grossly overused/abused excuse. Hurricanes and earthquakes can’t be predicted either, but residential building codes for hurricane and earthquake prone zones require construction techniques and materials which minimize damage, and construction is now prohibited in many areas know to be susceptible to flooding.

While true unpredictable “Black Swan” events, such as the meteor strike that destroyed the dinosaurs do in fact rarely occur, the collapse of asset bubbles always occurs, “things are *NOT* different this time,” and “trees do not grow to the sky,” no matter what the PowerPoint slides show (no matter how bad we want that to be the case).

Can bank insolvencies be prevented? NO, but the frequency can be minimized by limiting risky behavior (such as grossly excessive leverage) and the early detection of asset bubbles funded with bank loans collateralized with the bubble assets. Other palliative and ameliorative measures include limits on banker compensation, limits on bank size, intensive auditing, limits on the introduction and trade of novel financial instruments such as collateralized debt obligations and derivatives (which in too many cases are evasions of regulations) and greatly increased personal fiduciary accountability, both criminal and civil.

I agree completely. It’s certainly worth mitigating these risks in the way you suggest.

One problem is using our existing stress tests as an end-all-be-all. The dialogue around the stress tests seems to be, as long as banks pass, then we’re all good. The stress tests imagine a constrained future, one that looks conspicuously like the past.

That’s why some of your suggested countermeasures are more effective than others. Limits on bank size is a great example. Smaller banks may fail, but the consequences are less severe. We don’t have to predict exactly how these banks might fail. We can be more clever around managing the consequences.

But I’m with you, for sure.

Chip Javert

Aug 1, 2016 at 7:55 pm

George & Jeff

I agree too. Unfortunately our campaign contribution devouring congressman will not (he sleeps with the money).

Starter set for making banking safer:

1) Register all derivatives and require they trade on regulated exchanges; until this is fully implemented, all public firms must disclose total (not net) off-exchange derivative sales; individuals and non-public firms must disclose the same information to the IRS (we’ve never had a law implemented like this)

2) Define and enforce derivative margin requirements to minimize counterparty risk; until this is fully implemented, all public firms must disclose total derivative risk and total uncollateralized derivative risk; individuals and non-public firms must disclose the same information to the IRS (we’ve never had a law implemented like this)

3) Separate consumer banks, insurance and investment/brokerage banks. No non-consumer bank should ever be viewed as a “funding source” for high-risk activity (we more-or-less used to do this).

4) No consumer bank should be larger than x% (10%?) of the nation’s total consumer deposits (we used to have a law limiting this to 10%).

5) Assets financed with less than x% (10%?) down payment must remain on the books of the lending financial institution for the life of the loan (i.e. no securitization).

Even assuming the above are perfect answers to bank risk, there is no chance of adoption. Bank regulation and tax policy are the two largest magnets for campaign financing.

Big banks fund politicians. What else you need to know?! No failures will be tolerated for the chosen ones.

Captain KurtZ

Aug 1, 2016 at 10:59 am

Hi Wolf,

Can we talk about the derivatives portfolio that DB holds, the elephant in the room?

Is it all denominated in dollars? Euros?

Will a full-on redemption stampede collapse the system? Or just crash the currencies?

What is the plan afterwards?

Please tell us that someone has a plan for after DB?

Thanks for your great work.

Chip Javert

Aug 1, 2016 at 7:48 pm

Captain KurtZ

Im not speaking for Wolf, but a couple of the on-going unaddressed problems with derivatives is they do not have to be disclosed or registered, they do not have to be traded on a regulated exchange and there are no counter-party margin requirements.

Difficult to analytically talk about a financial black hole like that.

Chicken

Aug 1, 2016 at 11:11 am

Stewart Lewis seems to be describing sanctioned theft of public wealth by socialization of losses and privatization of gains?

a good bank would never waste money on preserving/idolising such a hypocrite “philosopher”. dude is the definition of a cocky, greedy, delinquent.

Deutsche deserves what is coming

OutLookingIn

Aug 1, 2016 at 11:36 am

Kind of reminds you of Bernanke saying;
“The sub-prime stress is contained”. Just before…

The great flushing sound could be heard, and the resultant blow up of the world financial system ensued. Only this time…

The coming global, debt fueled financial/monetary explosion will make the 2008 blow up look like a single little firecracker going off. Versus the mega-yield financial wipe out that just keeps on getting closer, with each passing day.

Chicken

Aug 1, 2016 at 11:41 am

One question though, if these euro banks aren’t in trouble then why do the bond holders face (steep?) haircuts? This isn’t an incentive to hold their bonds from my perspective.

So either there’s an EU bailout, in which case thieves and criminals are rewarded and unsuspecting victims are made whole at the expense of everyone, or the fuss and muss is contrived and an attempt at scaring people to accept losses at a moment of weakness?

Someone’s always getting screwed, question is whom?

Chip Javert

Aug 1, 2016 at 11:15 pm

Chicken

Specifically, the problem is the market (determines price of bonds) does not believe the bankers, politicians and stress tests.

Unsecured junior bail-in bonds (they go bust first) should never have been sold to mom & pop investors. It’s absolutely criminal that bankers were allowed to trick unsophisticated investors into buying them.

Undoubtedly bond owners originally bought them because they offered higher returns than regular savings accounts. Investors wishing to sell now will have to do so at a loss.

Why did bankers sell them to mom & pop? Because no one else was stupid enough to buy enough of them.

RE: …It’s absolutely criminal that bankers were allowed to trick unsophisticated investors into buying them.
Undoubtedly bond owners originally bought them because they offered higher returns than regular savings accounts….
—–
Be reminded that the U. S. banksters ran the same scam in the lead-up to the S&L “bust out” in the 1980s. In many cases the savers took money out of their FSLIC insured accounts to buy non-insured “certificates of participation” for the slightly higher interest. [Eat your heart out Tony Soprano!]

nick kelly

Aug 1, 2016 at 1:43 pm

I’m fascinated by the idea that somehow losses to the Italians holding worthless bank bonds CAN be avoided- unless the concept is to spread the loss over the entire EU, most of which needs similar aid from somewhere.

Or in other words, the idea that even though some point credit will be exhausted, austerity can avoided.
Before it became virtually a synonym for evil, austerity simply meant an end to borrowing. The problem with extending further credit to the most indebted places is that they are insolvent. Their economies don’t support their expenses, so they’ve borrowed the difference.

Much of the comment on this site is aimed at financial engineering- including the dire effects of endless central bank credit creation.
But austerity means the end of credit creation. They are different words for the same thing.

Chicken

Aug 1, 2016 at 2:27 pm

As long as central banks can keep their funny business contained behind the curtain, they can continue perpetrating fraud.

Credit and austerity are woven into the curtain.

chip javert

Aug 1, 2016 at 11:26 pm

Not really.

Printing money backed by economies that don’t produce much (applies to most of souther Europe) sooner or later results in inflation (def: too much money chasing too few goods).

I’d refer you to the Weimar Republic in Germany after WW1:

In 1919, one loaf of bread cost 1 German mark; by 1923, the same loaf of bread cost 100 billion marks.

The Germans are fanatical about this lesson – it’s one reason they’re so reluctant to stop saving & start spending.

RE: Before it became virtually a synonym for evil, austerity simply meant an end to borrowing. The problem with extending further credit to the most indebted places is that they are insolvent. Their economies don’t support their expenses, so they’ve borrowed the difference.
—–
In the abstract you are largely correct, but as is so frequently noted the devil is in the details.

“Austerity” is far too often used as an excuse to excessively lower wages and benefits, and abolish labor rights, driving the lower income strata into malnutrition, epidemics, ignorance, and homelessness.

“Austerity” like “prosperity” is unevenly and inequitably distributed when it is imposed, either by an outside agency such as the IMF, or by domestic shortages. A 10 or 20% fall in real disposable income will have little impact on upper income earners, who may have to drive their car an extra year or forgo a skiing trip, but will be a disaster for the lower income earners who are economically marginal even in “good times,” and who depend on the social safety net for food assistance, most medical care, affordable housing, general and vocational education, etc. Indeed, for the higher income strata, “austerity” may actually improve their standard of living by reducing the cost of domestic help to the extent college graduates are driven into employment as maids/valets, hall boys, yard boys etc.

It is suggested that any necessary “austerity” in the bad times should be allocated pro rata to the “prosperity” that was skimmed in the “good times.” How this could be done is unclear, but it may be possible to retroactively impose a surtax on prior year(s) [unearned] income taxed at capital gains rates using prior year(s) IRS databases.

michael

Aug 1, 2016 at 1:50 pm

“When it becomes serious you have to lie……”

Chicken

Aug 1, 2016 at 2:28 pm

Hubris allows one to believe in his own lies, I’m not making this up.

Julian the Apostate

Aug 1, 2016 at 3:42 pm

I actually read Taleb’s book the Black Swan. A Black Swan is defined as a totally unforeseen event such as the civil war in his home country that no one saw coming, because of the bias that says nothing like this has happened in the last thousand years. He calls this a normalcy bias. Then, when it does happen and knocks everything into a cocked hat, and people insist it will go back to normal. They may die believing it. To Taleb “normal” was reading in his basement while mortar rounds exploded in the yard. Because of his formative years he was able to spot the ’87 crash before it happened, much as Ayn Rand was able to predict current events in 1957 because of her formative years in the Bolshevik Revolution. I agree that the term is over used and has become a cliché like Catch-22, but it hardly has to equal the Permian extinction.
RE my comments the other day about Ambassador Stevens, while it is true the man’s death is politicized this in no way relieves Mrs. Clinton of her responsibility for letting those men die. Projecting liberal tactics onto their opponents is classic political theater, especially when they control the mass media. An emotional appeal based on a family member does not change the facts. The buck no longer stops here.

Vespa P200E

Aug 1, 2016 at 3:43 pm

Well this is what unrepentant Dick Fuld of Lehman said about its implosion last year – call it post-mortem from his bizarre angle:

1. “Lehman at the point in September of 2008 was not. A bankrupt. Company”

2. “Did we try to do everything we possibly could? Yes. Did we fall prey to some other agendas? I’ll leave it at that.” – Inferring that former competitors in regulatory positions with a vendetta against Dick.

3. “the worst of the impact of the financial markets is behind us” and pushed subordinates to take more risk, sidelining or firing those who disagreed with him

Anyway DB’s denials are nothing new all the while the leadership team is busy shuffling chairs while it is “slowly” sinking but my sense is that DB will be rescued as hey it’s TBTF.

nick kelly

Aug 1, 2016 at 4:45 pm

The amazing thing about Lehman is that the Fed seemed to think it could operate in bankruptcy- like an airline. Ya, we’re in Chapter 11, but apart from that its business as usual.
In the UK where Lehman had a major presence with over 20, 000 employees. the law is that a bankrupt financial outfit IMMEDIATELY ceases all operations as of that minute.
Corresponding outfits that had just deposited millions were now creditors.
This began the period where banks stopped trusting each other, and the collapse of the system loomed.
In Canada we had our own spin on this the Asset Backed Commercial Paper crisis.
Example: a Canadian miner Red (something) had just raised 300 million to develop a new mine. But because the money would be spent over 2 or 3 years, it wanted interest on the balance.
A bank suggested it could get half a percent more by putting the funds in
ABCP- not a deposit.
Then Lehman happened and the money was no longer available.
This eventually got sorted out and some fines were levied.
But once confidence and trust are lost, so is the system.

Chicken

Aug 1, 2016 at 8:04 pm

You seem naive to suggest this was a result of unfortunate circumstances or poor oversight, just like the recent Turkish coop the financial collapse was contrived by criminal enterprise.

So the Fed engineered the near collapse of the US banking system?
In Vanity Fair’s excellent overview: The Week Goldman Almost Died, it describes the stress Bernanke and crew were under in the week up to Lehman and after – they were sleeping on cots in their offices, having shouting matches with bankers who were reluctant to merge with Lehman as the stock went from 200 to 5.
They wandered around looking red eyed and unshaven, at times looking like they might ask for spare change.
The crash certainly ended Bernanke’s hopes of a smooth gig- he spent most of his term in one crisis after another.
But those millions in a Swiss bank make it worthwhile right?

EVENT HORIZON

Aug 1, 2016 at 7:12 pm

As long as the Central Banks can issue unlimited “credits” to anybody’s account…….there is nothing to stop this. Nothing. I, personally, could not care less about the nation states if I had the right to issue a nations currency.

chip Javert

Aug 1, 2016 at 11:29 pm

Event horizon

I’m reposting what I said earlier:

Printing money backed by economies that don’t produce much (applies to most of souther Europe) sooner or later results in inflation (def: too much money chasing too few goods).

I’d refer you to the Weimar Republic in Germany after WW1:

In 1919, one loaf of bread cost 1 German mark; by 1923, the same loaf of bread cost 100 billion marks.

The Germans are fanatical about this lesson – it’s one reason they’re so reluctant to stop saving & start spending.